Trader’s Narrative

Last week we took a look at a recent research report from Morgan Stanley on the aftermath of secular bear markets. Although in that article I featured this chart comparing the Nasdaq market from its peak in 2000 to now with the infamous Dow Jones Industrial index top in 1929, it deserves another mention. You can click on the graph to see it in full size:

I’m always fascinated by the fractal nature of the stock market. But I’m not convinced this isn’t just a random coincidence. Here’s another chart from Bloomberg comparing the S&P 500 with the Nikkei:

Again, an uncanny similarity. Again and again, markets seem to follow the same script. Or rather, the individual participants act with synchronous precision to create and unravel manias.

Another interesting comparison I mentioned a while ago is this year’s spring rally in the S&P 500 with that 6 years ago: Comparing Flag Formations: Then & Now. But where we part company from the past is when we look at the magnitude of this most recent rally.

This surge has offered no real opportunities for those who hesitated at its inception and waited for a pull back. In fact, the rally from the March 2009 lows has been the sharpest we’ve had in 40+ years:

If you consider each rally chronologically, something becomes noticeable: with the exception of the 1982 example, each subsequent bull market rally has been slightly sharper than the previous one. Maybe there is a pattern there. But it is hard to statistically defend since the observable sample is so small.

While the Chinese stock market bubble was brewing, a lot of people ignored it and frothed at the mouth about the over-valuation in the US market.

In keeping with that odd behaviour, while the US market has now fallen less than half the distance of the Chinese market (from their respective October 2007 tops), most people are more concerned about the US markets and again are ignoring the very real and brutal bear market in China.

Part of the explanation is that the US markets are obviously much larger and have more significance on the world stage but still, a bear market is a bear market. And over in China they are grappling with a big one.

Bubble, Bubble, Toil & Trouble
The Chinese stock market has gone through bubbles before. This time it only multiplied by a factor of 6 in less than 2 years!

But tha’s nothing compared to 1991 when it multiplied by ten in about a year. Remarkably this recent mania was so strong that it shrugged off a trading stamp tax increase last summer and continued to rally for a few months. Usually such state manipulation would have meant a quick death to the mania.

Click To Enlarge Graph:
To the left is a graph showing the S&P 500 and the Shanghai Index since March 2003, the bottom of the last bear market.

Since the bull market in Chinese shares lasted longer than most predicted, it is safe to say that the bear may last longer also. The next level of support is around the 3000 level. After that, the resistance levels from 2000-2001 will come into play at the 2000 price levels.

Probably the best timer of Chinese stocks has been the editor of the newsletter, Cabot China & Emerging Markets Report. Their virtuoso performance in BRIC emerging markets brought them the trophy of the best newsletter in 2007. For the record, they turned negative in November 2007 right after the top and are continuing to stay away.

The editor, Paul Goodwin, uses an extremely simple way to enter and exit the market: 50 day and 25 day moving averages of Halter USX China Index (HXC). That’s it. Trading doesn’t have to be complicated.

Chinese ADRs
Although there are quiet a few individual Chinese ADRs trading on US exchanges, the only way that I know to actually trade Chinese equities (the A shares) is through the Morgan Stanley A Shares Fund (CAF). It has fallen from almost $61 in October 2007 to its current price in the low $30’s.

As a trading vehicle it is an imperfect one because it doesn’t track the Shanghai index very well. But unless I’m mistaken, it is the only way to get your hands on those A shares from outside China.